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Earnings Management Just as Bad under IFRS as U.S. GAAP

An academic study demonstrates that earnings management is pervasive across U.S., European and Asian companies, whether they’re using U.S. GAAP or International Financial Reporting Standards.

The study looked at whether senior financial officers at large and small public and private companies would recommend using their discretion to manage earnings under different scenarios. Michael Peters of Villanova University's School of Business and the co-authors of the study, Mark E. Evans of Wake Forest University, Richard W. Houston of the University of Alabama, and Jamie H. Pratt of Indiana University, enlisted 616 financial officers from companies in the U.S., Asia and Europe using U.S. GAAP and IFRS.

They found that the level of earnings management was approximately the same across the U.S. and non-U.S. study participants. When managing earnings, however, the Asian and European companies that used IFRS tended to rely more on accounting earnings management, while the U.S. companies that used U.S. GAAP emphasized real earnings management.

The study, “Reporting Regulatory Environments and Earnings Management: U.S. and Non-U.S. Firms Using U.S. GAAP or IFRS,” appeared in the September 2015 issue of the American Accounting Association’s journal The Accounting Review.

Peters believes the results can be attributed to several factors:

1. There’s more discretion to use accounting earnings management under IFRS as opposed to U.S. GAAP.

2. The regulatory environment in the U.S. is much more extensive and the consequences are more severe, compared to Asia and Europe.

3. The litigation exposure in the U.S., both civil and criminal, is more likely to challenge companies’ wrongful accounting practices. The result is that firms in the U.S. that employ U.S. GAAP are less willing to do accounting earnings management to arrive at a particular earnings figure compared to their European and Asian counterparts that operate under IFRS.

Still, stronger reporting environments do not necessarily reduce earnings management. Instead they allow for the substitution of accounting for real methods.

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